Home Loans From Family and Friends

More first-time homebuyers are turning to loved ones to secure loans to purchase a new home. Everyone legally can borrow from family and friends if both parties are willing. If homeowners handle loaning money correctly, everyone can end up winning.

These loans are often referred to as:

• Private home loans or private mortgages

• Personal loans

• Intrafamily mortgages

They are not as uncommon as you might imagine. In many respects, they are almost the same as a mortgage that you could get from the bank or another traditional mortgage lender.

These Types of Loans Are Common When:

• You have trouble securing a mortgage loan from a bank.

• You have difficulty saving for a down payment.

• You don't want to get involved in the mortgage programs that banks offer.

• It seems easier than using a bank or payment program.

• Your personal finance situation is difficult, such as when you're facing foreclosure of your primary residence.

• Married couples are overwhelmed by the home-buying process, and their parents want to help.

Table of Contents

• What Is the Private Home Loan Process?

• Benefits for Borrower

• Benefits for Lender

• The Paperwork for a Private Loan

• After You Get the Private Loan

• Setting Up a Private Loan With a Lawyer's Help

What Does a Private Home Loan Process Look Like?

The homeownership loan process can be flexible for all parties involved. For example, let's say you have a private loan for $50,000 for a home. Just like with more traditional loans and mortgages, you will probably have to agree to:

• Sign several legal documents that go along with the private home loan (more paperwork info below)

• Make steady mortgage payments each month until the loan is paid off

  • Example: $1,000 a month for 50 months, or just over four years.

• A set interest rate and pay the interest each month 

  • Example: a 3.9% interest rate, which brings your interest to $39 a month and brings your total payment to $1,039 per month

  • Over time this means you will pay $51,950 total for the loan because $1,950 is in interest

You may also have to agree on your private lender:

• Holding a lien on the home you buy

• Demanding payment in full if you fall behind on payments

• Foreclosing on your property (just like a bank) if you fall behind on payments

• Asking you to sell the house to make good on the outstanding balance of the loan

Like with a bank, you would also have rights against the private lender as well. When borrowing from family or friends, the law still applies. They can't ask for all the money upfront without just cause that comports with the law and the terms of the loan. For instance, they can't demand all the money back because you missed your grandmother's 80th birthday or broke away from family.

Benefits of a Private Loan: For the Borrower

Opting for a private loan may offer several benefits compared to going to a bank. For example, you may be able to get the loan you need at a lower interest rate than you could have received from a bank. 

At the same time, the people you borrow from may be able to get an interest rate better than even the best savings account can offer. For example, if market rates are 8% for mortgages and 4% for savings accounts, your family might agree to 6% interest. That benefits both you (as a borrower) and your family (as savings investors).

These Benefits Could Include:

• Low-Interest Rate: Banks are in the business of making money, and to this end, you are often at their mercy if they wish to charge a high mortgage rate. Because of the nature of private loans, however, your private lender may fix your loan at a lower rate than you would ever see coming from a bank. The example above demonstrates this scenario.

• Payment Flexibility: You're under less pressure regarding formalities. Unlike banks and other institutional lenders, a private lender will most likely allow you to vary your payment schedule depending on your circumstances. Also, a private lender would probably not impose penalties for things like early repayment, whereas banks commonly engage in the practice.

• Federal Tax Deductions: You can deduct from your federal taxes while borrowing from family or friends. You can take the same IRS tax deductions for your private loan as you would for conventional loans.

• Better Loan Terms: This one is especially true when you're dealing with family. You won't have to worry about closing costs or other hidden fees affecting your bottom line. Your family members are also less likely to give you a hard time about your credit score, credit card debts, home equity, and debt-to-income ratio (DTI). If they trust you from experience, they won't nitpick over your personal finances as much as a bank might. They also might not care if the money goes to an investment property versus a home purchase.

Benefits of a Private Loan: For the Lender

In addition to benefiting the borrower, a private loan also benefits the private lender. These benefits could include things like:

• A Better Rate of Return: Private lenders can offer the borrower an interest rate between the highest savings-account interest and the lowest mortgage rate. By doing this, everyone wins. Again, refer to the 6% example above. The borrower gets a great interest rate, and the lender's money earns more than it would from sitting in a savings account.

• Steady Income: Like conventional mortgages, private loans are paid over a period of time. Because of this, the lender has the opportunity to have a steady source of reliable and dependable income.

The Paperwork for a Private Loan

Suppose you agree with a friend, family, or loved one to have them finance all or a portion of your home loan. You should treat it just as a bank would. To this end, you should draw up the necessary paperwork, such as a promissory note and various documents that go along with a mortgage. Also, consider putting down a proposed repayment schedule in writing.

• Promissory Note: Commonly called a mortgage note. This is a binding document signed by both you and your lender. It says you agree and promise to repay the loan under specific terms. The terms that must be included in this note are:

  • The interest rate

  • The loan principal

  • Payment dates

  • The period between payments

  • Any penalties that may be imposed for late payments or nonpayment, such as requiring full payment of the loan if certain conditions occur.

• Mortgage: Also known as a deed of trust, the mortgage document is the legally binding document that secures the promissory note. This gives the lender the legal authority to foreclose on the property if you do not pay off the entire loan. They may also collect fees and interest within a specified time. The mortgage document needs to include:

  • The recognized owner of the property

  • A legal description of the property

  • The borrower's responsibility to pay off the promissory note

  • The borrower's responsibility to maintain insurance

  • Any regulations to keep the property in good condition

  • Rules regarding if the lender may ask for full payment on the loan immediately if you, as the borrower, fail to comply with the mortgage

• Repayment Schedule: Although it is not legally required, it is still a good idea to put down in writing the agreed-upon repayment terms. This will help avoid any unnecessary strain between you and your private lender.

After You Get the Private Loan

Like a traditional loan agreement, you can still face problems paying off the loan. Contact your private lender as soon as possible. Because your lender will be family or a friend, you may be able to work out a solution. They may consider forgiving some payments on the loan or allowing you to refinance. It would be best to avoid taking advantage of this in excess, however, as it may significantly strain the relationship between you and your lender.

Setting up a Private Loan? You May Want To Speak With an Attorney

Buying a home is the biggest transaction you will likely make in your lifetime. While it may be considered a healthy form of debt, it's still a huge commitment. Your real estate agent or Realtor may offer limited advice, but it won't cover all your legal bases.

You may encounter multiple legal issues when closing on a home sale or securing financial resources. This is true even if you can procure home loans from friends and family. Consider speaking with a real estate attorney to ensure your private loan terms protect your interests.